Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this Form 10-K for the fiscal year ended May 31, 2018, with fiscal 2017 as the main comparison. This is an annual filing, not a standalone 2017 Q4 report; quarterly figures are provided for fiscal 2018. CFC is a member-owned, tax-exempt cooperative lender focused primarily on rural electric utilities. Consolidated results include NCSC and RTFC.
Financial performance and position
- Revenue and earnings: Interest income was $1.077 billion, interest expense $792.7 million, and net interest income $284.6 million, down 3% from $294.9 million. Fee and other income was $17.6 million. GAAP net income was $457.4 million, versus $312.1 million in 2017.
- Important earnings distinction: The 2018 result included $231.7 million of derivative gains, principally noncash fair-value gains as interest rates rose. Adjusted net income, which excludes derivative forward-value gains and includes derivative cash settlements, was $151.4 million versus $132.7 million. Adjusted TIER was 1.17, compared with 1.16; management’s stated annual goal is at least 1.10.
- Margins: GAAP net interest yield declined to 1.12% from 1.20%; adjusted net interest yield declined to 0.83% from 0.86%. Higher funding costs—particularly on short-term and variable-rate borrowings—more than offset modestly higher asset yields.
- Lending and credit: Loans to members rose 3% to $25.18 billion. Approximately 99% were to electric utility organizations; 93% of loans were secured. There were no delinquent or nonperforming loans at year-end and no electric-loan defaults or charge-offs for the fifth consecutive fiscal year. The allowance for loan losses fell to $18.8 million from $37.4 million, primarily following revised recovery-rate assumptions.
- Cash flow: Operating cash flow was $155.2 million; investing activities used $1.197 billion, including net loan advances and $510.6 million of purchases of held-to-maturity securities; financing provided $1.106 billion. Cash and cash equivalents increased $64.4 million to $231.0 million.
- Debt and equity: Total debt increased 5% to $24.63 billion, while total equity rose to $1.51 billion. The GAAP debt-to-equity ratio was 16.72x, down from 21.94x; adjusted debt-to-equity was 6.18x, up from 5.95x and above management’s approximate 6.00x target. Short-term borrowings were $3.80 billion, with a 1.88% weighted-average rate and 35-day weighted-average maturity.
- Liquidity: Reported liquidity reserves were $7.15 billion, including $231 million cash, $3.08 billion of available bank revolving credit, up to $1.23 billion under the Guaranteed Underwriter Program, and Farmer Mac facilities. Long-term debt maturities over the next 12 months were $2.75 billion. CFC reported compliance with its debt covenants.
Changes, outlook, risks and unusual items
- Net income rose mainly because derivative gains increased by $136.8 million and the loan-loss provision shifted favorably by $24.6 million; lower net interest income and higher operating expenses partly offset this. Adjusted net income improved by $18.6 million.
- Management expected net interest income and yield to increase over the next 12 months, citing anticipated lower funding costs as higher-cost debt matures and continued loan growth. It expected loan advances to exceed repayments and adjusted leverage to remain above 6.00x. These are expectations, not guarantees.
- After year-end, CFC redeemed $300 million of its $1 billion, 10.375% collateral trust bonds due November 2018. The filing states that $700 million remained outstanding after the redemption.
- Key risks include dependence on capital markets and other funding sources; higher borrowing costs or rating downgrades; interest-rate and derivative-counterparty exposure; concentrated lending to the rural electric sector; and borrower credit deterioration. A downgrade triggering termination of certain swaps could have required a net payment of up to $81 million as of year-end under the specified scenario.
- One electric distribution cooperative and subsidiary, with $165 million of loans, were downgraded to substandard due to losses and weak cash flow. They remained current, most of the exposure was secured, and management did not consider the loans impaired.
- Legal proceedings were described as ordinary-course matters; management did not expect a material adverse outcome and had recorded no related reserve. CFC reported no foreclosed assets at year-end. Its financial statements received an unqualified audit opinion; the auditor did not attest to internal control over financial reporting.
Most important facts for investors to verify
- Separate recurring lending performance from noncash derivative fair-value gains; review adjusted measures alongside GAAP results.
- Assess whether the lower loan-loss allowance remains supportable given revised recovery assumptions, the substandard $165 million borrower exposure, and the portfolio’s sector concentration.
- Confirm liquidity access, refinancing plans for the $2.75 billion of near-term long-term debt maturities, and continued covenant and collateral compliance.
- Monitor adjusted leverage above management’s target and the effect of loan growth and funding costs on adjusted earnings and margins.
- Review derivative rating-trigger exposures and the assumptions behind management’s 12-month outlook.